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Debtor Management or Receivables Management

Posted in Financial Accounting, Financial Management on Feb 20th, 2014 | 0 comments

Debtor Management or Receivables Management

Profit is directly proportional to the volume of sales, provided all your business transactions are cash based. Is it possible for a manufacturer, wholesaler or retailer to carry on his business without offering credit in this competitive business environment? The answer is a definite “no”, because extension of credit improves your sales and thus your profit. Problems arise only when a firm is not able to recover the debt within the stipulated period of time from the customers.

What is receivables management or debtors’ management?

It covers two aspects- one, the kind of money that is being invested in debt rotation; second, the risk factor which includes loss of money or the opportunity cost foregone by the organisation. Had these funds not been tied in receivables, the firm would have invested the same elsewhere and earned income thereon. A transaction entirely through cash is definitely a possible option, but whether it is lucrative in the long run must be subject to consideration. When customers are not offered credit, they choose concerns that extend credit facilities and thus you may lose your earlier customers and also exposed to the risk of declining sales proportions.
debtor management

Credit Sales

In credit sales, the supplier offers credit for a specific time period, which is an investment from the angle of supplier and largest single source of short term financing from the angle of the customer. The supplier should be able to recover the amount of interest on the credit investment he has made. How?

  • Recovery of debt within the stipulated credit period
  • Taking interest from the customer for the period of delay
  • Volume sales
  • Surplus capital to offset these negative impacts on rotation of funds
  • Proper formulation and execution of credit policies by the finance manager
  • Discipline in collection policy and its execution.

Discounts

Cash discounts, quantity discounts and trade discounts are offered by many firms to the customers to encourage credit sales, favoring bulk purchases. A firm cannot be expected to survive long by pursuing the policy of cash sales while similar firms can overtake it by adapting to liberal credit policies.

The main aspects of receivables management decisions are as follows:

  • Time period of credit
  • Credibility of the customer
  • Cash discounts
  • Trade discounts
Learn the basics of the Income Statement, Balance Sheet and Cash Flow Statement and understand how they fit together. icon

Credit Policy

Credit policy on one hand stimulates sales and so also its gross earnings, but on the other may be accompanied by added costs, such as:

1) Clerical expenses involved in investigating additional accounts and servicing added volume of receivables,
2) increased bad-debt losses due to credit extension to less credit worthy customers,
3) higher cost of capital.

Incremental earnings from increased sales should be matched with incremental costs that arise due to credit terms, to avoid funds being tied up in receivables. In course of time it would deprive you of your profits. The pivotal consideration of your credit policy would be the selection of credit worthy customers or debtors. If your funds become sticky, recovery becomes next to impossible and you need to proceed legally to claim your rights. Properly maintained accounting records and vouchers will stand as a testimony in your favor, in the court of law.